Intercompany financing transactions, attribution of losses, business restructuring and intellectual property migration have all come under greater focus from the tax authorities.
The drive to increase revenue means transfer pricing practices are evolving quickly and the report provides a global round-up of the different approaches.
Europe
In Europe, KPMG reports “the expansion of transfer pricing rules...is nearly complete”. With guidelines and rules covering documentation introduced or being introduced across the region, governments are actively encouraging compliance.
Mutual agreement procedures (MAPs) and advance pricing agreements (APAs) are more common across Europe too.
“Requests for UK APA expressions of interest have also increased, demonstrating the importance of certainty to clients,” said Shiv Mahalingham, of Alvarez & Marsal –Taxand in the UK.
The report said that, due to increased audit, taxpayers have altered their policy, including showing more interest in dispute resolution.
But, the added scrutiny from authorities is not necessarily due to tax base protection, said Mahalingham.
“My dealings with HMRC indicate that there is no specific mandate to attack firms operating in the UK using transfer pricing just because of a requirement to manage the overall tax base. Aggressive tax planning structures that have a significant UK tax impact will always be under scrutiny, whether related to transfer pricing or other areas of taxation.”
“That said, we are starting to see more requests from clients to resolve disputes than at the same time last year,” he added. “Part of this is because of HMRC’s welcome commitment to afford business a “stay of execution” under a difficult economic climate.”
But, the cost of dispute is still a major factor for both sides.
“Litigation costs HMRC and it costs businesses – therefore, the recent UK transfer pricing cases, while polarising the transfer pricing debate, have not opened the way to a slew of transfer pricing cases, as many have reported,” said Mahalingham. “HMRC and businesses will apply cost-benefit analysis as they have always done when assessing whether to pursue disputes through the UK courts or settle the matter at the audit stages.”
Mahalingham added that the notion of a Tobin tax (a levy on financial transactions) has meant dealing with business requests concerned with potential redomiciliations.
“The proposed Tobin tax has renewed requests from financial services groups asking us whether they should commercially relocate operations out of the UK.”
North America
In the US and Canada, transfer pricing receives a significant amount of attention from the authorities too. Canada has become known for its stringent transfer pricing audits.
“One of the challenges in interpreting the Canadian transfer pricing rules is the absence of case law providing adequate clarification,” said Louise Summerhill, of Aird & Berlis, and economist, Dr. Jennifer Shulman, in their recent article Canada’s Transfer Pricing Rules.
Two recent cases in Canada that highlight the time and cost involved in transfer pricing tax disputes are GlaxoSmithKline Inc v The Queen (2010 FCA 201) and General Electric Capital Canada Inc v The Queen (2009 TCC 563). The time and cost of litigation means taxpayers are exposed to greater uncertainty. Hence, most taxpayers prefer to seek an APA or other alternative.
“Because an APA is generally a negotiation, the final outcome is not guaranteed to be the same as the taxpayer’s final position,” said Shulman and Summerhill.
Latin America
Fifteen years ago there were barely any rules governing transfer pricing across the region but now many countries have adopted rules based on OECD guidelines.
In Brazil, a system of statutory margins is used that is not based on the arm’s-length standard.
“In light of this stance and Brazil’s importance as a trading partner in the region,” the report said, “MNEs [multinational enterprises] must tread carefully in their intercompany transactions within Latin America”.
“Transfer pricing rules were set forth by Law 9430 in 1996 and became completely enforceable in 1997. Such rules aim at avoiding that import and export prices and interest rates in international transactions are manipulated to reduce profits taxable in Brazil with the Corporate Income Tax and the Social Contribution,” said Luis Rogerio Godinho Farinelli, of Machado Associados, in Brazil.
Apart from not being based on the arm’s-length standard, the Brazilian rules differ from the OECD guidelines in other ways.
“The concept of related parties is broader than the concept of associated enterprises and reaches, for instance, transactions between Brazilian companies and their foreign exclusive distributors, or between a foreign company and its Brazilian exclusive distributor,” said Farinelli.
“Brazilian law adopted mathematical and objective transfer pricing methods, based on independent comparables, resale prices, or cost plus profit margins that differ from the OECD methods, especially in that predetermined profit margins were set out to calculate benchmarks,” he added.
There is no order of priority between the available methods for calculating transfer pricing benchmarks either.
“This allows the taxpayer to choose the method that leads to the lower tax adjustment, as a rule, contrasting with the best method rule used by other countries”, Farinelli said.
Asia Pacific
New compliance initiatives have also been inaugurated by tax authorities in the Asia Pacific region. With growing budgets for investigations, an emphasis on transfer pricing has emerged mostly aimed at standardisation across the area.
Though the number of MAP cases has been rising during the past few years in Japan, with Japan conducting MAPs with more than 20 countries, APAs are a more popular route for companies.
“Since countries do not necessarily reach an agreement by using MAPs, and the MAPs aimed to resolve taxation arising from an audit can be costly and time-consuming, many companies now opt to conduct APAs,” said Aya Sakuma, of Tokyo Kyodo Accounting Office.
Advance pricing agreements are an important development for the region, with an increasing number being offered by the tax authorities and various APA programmes being developed. Every year in Japan, close to 100 bilateral agreements are made, while in Korea and Australia, around 30 are concluded each year. As a comparison, the US concluded more than 100 APAs a year in 2006 and 2007, and now concludes around 70 a year.
“Due to factors such as the aggressive enforcement of the transfer pricing legislations by the Japanese tax authorities, the companies’ increasing concern towards compliance with the tax laws, expansion of business to the market of developing countries, and the companies’ need to be able to predict their annual performance, APAs have become a common method [of avoiding disputes],” said Sakuma.
“Generally, an APA procedure in Japan determines details such as the pricing method for prospective tax years (approximately five years). However, it is also possible to apply the agreed upon contents retroactively, to the previous years, and this is a method often used in Japan,” she added.
Sakuma also said the 2011 tax reform introduced several new concepts relating to transfer pricing rules. The reform has not been passed yet.
Among these new measures is the introduction of the best method, which will “greatly affect the selection of the transfer pricing method in the future,” said Sakuma. Assessment on transfer pricing falling within a prescribed range is another measure dealt with by the reform.
“The 2011 tax reform proposal explicitly states that the tax authorities will not impose assessments if the transfer price falls within a prescribed range. If the transfer price happens to fall outside of such range, the tax authorities will make it clear that a reasonable arm’s-length price can be derived, taking the distribution and average of the financial data of comparable companies into consideration,” said Sakuma.
The overriding message of KPMG’s report is that government scrutiny means rapidly evolving rules for transfer pricing. But this does not mean that companies cannot effectively manage their transfer pricing affairs.
Planning, in the form of developing economically supportable policies for transfer pricing, as well as implementing those policies while monitoring transactions, is important.
Compliance through documentation and the resolution of transfer pricing disputes, through APAs, competent authority negotiations, arbitration and litigation support, is also cited as a key area of focus to avoid strict penalties.